Tuesday, March 1, 2011

THE CHALLENGE - REDUCING CORPORATION TAX

“In order to spur investment by Welsh-based companies and attract high value added foreign direct investment, the Welsh Conservatives should lobby the UK government for reduced corporation tax for Wales”

For the last two decades, Wales has attracted billions of pounds of foreign direct investment (FDI) through generous grants or subsidies. Whilst this may have stabilised private sector investment in some parts of the Welsh economy, the selective nature of such grants means that it is unlikely that there will be any immediate change to narrow the prosperity gap between Wales and the rest of the UK. More importantly, such grants, whilst important to individual companies, can only provide limited assistance to the existing indigenous private sector in growing in Wales. In order to spur investment by Welsh-based companies and attract high value added FDI, the Welsh Conservatives should lobby the UK government for a reduced corporation tax rate for Wales as this is the only major economic structural change that can lift the Welsh economy from the bottom of the UK prosperity league table.

The Evidence

Recently, there have been calls from the private sector for corporation tax to be reduced within another devolved region of the UK. Earlier this year, the Northern Ireland Economic Reform Group of senior economists, accountants and business interests launched a major report on reduced corporation tax for the province[1]. It concluded that “reduced corporation tax is the fastest way we know to revitalise the Northern Ireland economy” and estimated “that more than 90,000 extra jobs could be created over 20 years and that the subvention could be cut at a relatively small cost to public expenditure”. This was followed by a further study from the accountants PWC[2] which noted that “as economies with relatively large public sectors in an environment where UK public spending is to be cut, the status quo with respect to policy (including continuation of the Treasury’s traditional one size fits all approach to taxation across the UK) will simply doom Northern Ireland, Scotland and Wales to fall further behind the UK average”. Unfortunately, no business or government body in Wales has undertaken a similar study to examine the impact of lower corporation tax on the Welsh economy although a recent paper from Cardiff Business School suggested that a significant reduction in corporation tax in Wales could create around 16,000 additional jobs[3].The UK Coalition Government has already indicated that it may be willing to consider a regional tax approach after offering new firms based outside the three most prosperous regions in the UK a £900 million tax break. Focusing on a pre-election promise on those regions hardest hit by the recession, any company set up outside London, the South East of England and East England will not have to pay employer National Insurance contributions (NICs) for the first ten employees taken on during its first year in business. Given that the reduction in NICs for new firms has been regionally focused, there is no reason as to why other future tax measures may also focus on those parts of the UK in greatest need of support i.e. those areas that are overly dependent on the public sector and desperately need private sector jobs. With Wales remaining at the bottom of the UK prosperity league table, any measure that directly helps those running Welsh businesses cannot come quickly enough.

The Way Forward

If elected, the Welsh Conservative Party should seek immediate and urgent discussions with the UK Government and the other devolved administrations about the feasibility of reducing corporation tax in Wales to encourage investment and create vital employment at a time when the economy is recovering from recession.

CASE STUDY

THE HOLTHAM REVIEW AND CORPORATION TAX

According to the Holtham Review[4], one theoretical approach could be to make changes to the rate of corporation tax that were proportional to the difference between GVA per head in a given region and the UK average.

“For example, one could ignore the first ten percentage points of deviation in GVA per head and say regions with a GVA per head between 80 and 90 per cent of the UK average could discount corporation tax by up to 15 per cent of the tax rate in force across the rest of the UK. Regions with a GVA per head of between 70 and 80 per cent of the UK average could discount by 25 per cent, those between 60 and 70 per cent by 35 per cent. The discount could be multiplied by a factor so the above discounts would become 30, 50 and 70 per cent respectively if the factor were 2; the key would be proportionality with the GVA shortfall in the region concerned. Companies wishing to claim the discount would have to demonstrate economic activity in the region concerned. This should not be a “brass plate” exercise; the location of head office would not be relevant. Corporation tax liability would depend on the location of economic activity. Evidently that could be defined in various ways but many countries, including the USA, have well-tried formulae forallocating corporation tax bases across regions. The simplest approach would be to allocate liability by proportion of payroll with the stipulation that payroll administration has to follow the physical location of the employees. Once activity is assigned to different regions it becomes possible for the tax rate to vary by region. It would be for the company to establish the location of its activities. The most straightforward way of varying corporation tax across the UK would be for this to be done by the UK Government; corporation tax would remain a UK tax, with no implications for devolved administration budgets. The tax would be collected by HMRC and receipts would accrue to the UK Government as at present.”

[1] Economic Reform Group (2010) The Case for a Reduced Rate of Corporation Tax in Northern Ireland, May 2010.

[2] PWC (2010) Making the most of devolution - How Northern Ireland can maximise economic gain from the new coalition government